This phenomenon occurs in the realms of day trading as well as longer-term investing. In both areas, the masters of the market try to shake other traders out of promising long or short positions by precipitating quick reversals in the prevailing trend.

For example, news plays are the foundation of day trading where speed is essential. A positive headline for stock ABC is usually followed by a spike in buy volume that shoots the price higher. This can last five minutes or less. The spike is often followed by a shake in which the price falls sharply as the surge in volume subsides and early birds sell and pocket their profits. A typical retracement is 50%. So if ABC jumps from 10 to 11, it tends to drop to around 10.50.

This is usually enough to scare out traders who came late to the party and bought ABC around 11. The shake is usually followed by another substantial move higher, and thats where savvy traders jump back into the stock for further profits.

In longer-term positions, a shake often triggers the stop losses that wise investors place below their entry price (or above in the case of a short). They trail the stop behind the stock as the price advances. We usually recommend using a 10% stop loss; if you buy ABC at 10, you place the stop loss at 9. If ACB rises to 11, you adjust the stop to 10 or so. If it hits 12 you adjust to around 11, and so on. Using a stop protects your position against severe loss and locks in profits.

But market makers have an uncanny ability to judge where the majority of stops are sitting for a particular stock. If ABC is at 12 and loads of stops are at 11, its usual to see enough selling hit the stock to take in down to 11 and trigger all those stops. That shakes investors out of their position as the stock is sold.

It is frustrating to be shaken out of a good position only to watch the stock resume its winning move, but it is the way the game is played. Its no reason to quit using stops, because all too often a reversal can whack 20 or 30% off the price of a stock before it regains its footing. We dont want to be around for that.